When renowned value creator Brookfield Asset Management (BN 1.35%) took control of TerraForm Power (TERP) in late 2017, it wanted to transform the renewable power company into a total return machine. Brookfield's strategy was to shore up TerraForm's balance sheet, reduce costs at its legacy assets, and grow the company's wind and solar platform to support a sustainable high-yielding dividend that it could increase at a mid-single-digit annual rate. Brookfield believed its plan would generate double-digit total annual returns for investors, including itself since it holds a sizable stake in the company.
The companies made "significant progress" on their plan during 2018, according to TerraForm Power CEO John Stinebaugh on the fourth-quarter conference call, where he ran through their success on each of the three pillars of their strategy.
1. We expanded our renewable energy portfolio
Stinebaugh stated on the call that the first pillar of the company's value-creating strategy was to "invest on a value basis in operating wind and solar assets in North America and Western Europe." The company did that by "invest[ing] $1.2 billion to acquire Saeta, increasing our asset base by 40%. With Saeta, we acquired a 1,000-megawatt portfolio of high-quality wind and solar assets primarily in Spain at a very attractive value, and we established a scaled operating platform from which we will continue to build our European operations."
The company was able to get a good deal on Saeta due to some uncertainty in the Spanish regulatory environment because of an upcoming rate reset next year. While the company based the deal on a negative outcome, it's increasingly optimistic that the government won't reduce rates as much as the market feared, which would enable it to earn even higher returns on its investment.
In addition to Saeta, TerraForm invested another $28 million on several other growth initiatives, which Stinebaugh believes will "earn a return on equity of approximately 19%." These investments included exercising its right of first offer to purchase a small solar facility in the U.S., buying out some minority partners, and acquiring a small solar asset in Spain as it looks to consolidate that market following the Saeta transaction. These growth-focused investments position TerraForm to expand earnings and cash flow in the coming years.
Check out the latest earnings call transcript for TerraForm Power.
2. We improved our legacy assets
Next, Stinebaugh noted that the company wanted to "enhance the value for our existing assets by optimizing costs, increasing revenue, and investing in organic growth." It did that in several ways. On the cost-cutting side, the company "executed an 11-year framework agreement with GE to enter into long-term service agreements [LTSAs] for turbine operations and maintenance, as well as other balance of plant services for our 1.6-gigawatt North American wind fleet. Once the LTSAs are fully implemented, which we anticipate will occur in the first half of this year, we expect to realize $20 million of annual cost savings on a full-wrap basis."
Meanwhile, the company also took steps to boost the revenue of its existing assets. Stinebaugh noted that:
We successfully executed our solar performance improvement plan to enhance revenue. Following irradiation scans of nearly all of our North American solar facilities, we have identified and remediated all high-priority issues that caused production deficiencies within our solar fleet. On an annual basis, production from our fleet is expected to increase by 61 gigawatt hours per year, which should equate to $11 million of revenue.
The company also made several organic investments as part of the additional $28 million it invested last year. These included expanding one of its solar farms and investing in a battery storage project in Hawaii. In addition to that, the company progressed some longer-term projects to repower its wind farms in New York and Hawaii. TerraForm would replace its existing turbines with larger, more powerful ones that should boost electricity production by 25% to 30%. This combination of cost reductions and revenue growth will help increase cash flow in the coming years.
3. We shored up our balance sheet
The third pillar of TerraForm's value-creating strategy is strengthening its balance sheet. Stinebaugh noted that the company accomplished this due in large part to the Saeta acquisition where it sold stock to Brookfield to finance the transaction as well as refinancing some of its other assets. Stinebaugh commented that "once we close the final project financings in the first half of 2019 and our results reflect a full year of contribution from Saeta, our balance sheet should deleverage significantly." The company's progress in improving its balance sheet enabled it to receive a credit rating upgrade, which will increase its access to capital as well as reduce its borrowing costs -- although its credit rating remains below investment grade, so it still has some work to do to improve its balance sheet.
The future looks bright
Stinebaugh closed his comments on the call by stating that "as we look forward, we are optimistic about TerraForm Power's prospects in light of the foundation for growth that we built in 2018." He noted that the company is considering several additional value-based acquisitions, plans to continue improving its legacy operations, and aims to "further strengthen our balance sheet with a long-term objective of achieving an investment-grade rating." As this progress continues, it increases the likelihood that the company can generate low double-digit total annual returns, which makes it an appealing income stock to buy for the long haul.